Cabot Vineyards has been paying a regular cash dividend of $4.80 per share each year for...

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Cabot Vineyards has been paying a regular cash dividend of $4.80per share each year for over a decade. The company is paying outall its earnings as dividends and is not expected to grow. Thereare 118,000 shares outstanding selling for $80 per share. Thecompany has sufficient cash on hand to pay the next annualdividend.
Suppose that, starting in year 1, Cabot decides to cut its cashdividend to zero and announces that it will repurchase sharesinstead.
a. What is the immediate stock price reaction?Ignore taxes and assume that the repurchase program conveys noinformation about operating profitability or business risk.
b. How many shares will Cabot re-purchase?
c. Project and compare future stock prices forthe old and new policies for the next 3 years. What is the annualreturn to shareholders under each of the policies?

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4.2 Ratings (670 Votes)

a If we ignore taxes and there is no information conveyed by the repurchase when the repurchase program is announced then share price will remain at 80 b The regular dividend has been 480 per share and so the company has 480 x 118000 566400 cash on hand Since the share price is 80 the See Answer

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Cabot Vineyards has been paying a regular cash dividend of $4.80per share each year for over a decade. The company is paying outall its earnings as dividends and is not expected to grow. Thereare 118,000 shares outstanding selling for $80 per share. Thecompany has sufficient cash on hand to pay the next annualdividend.Suppose that, starting in year 1, Cabot decides to cut its cashdividend to zero and announces that it will repurchase sharesinstead.a. What is the immediate stock price reaction?Ignore taxes and assume that the repurchase program conveys noinformation about operating profitability or business risk.b. How many shares will Cabot re-purchase?c. Project and compare future stock prices forthe old and new policies for the next 3 years. What is the annualreturn to shareholders under each of the policies?